The last months of summer have seen notable developments in the debate over reform of the alternative investment industry in the United States and the European Union. After a financial collapse in 2008 that many believed was fueled, at least in part, by hedge funds that took on too much risk in the form of highly leveraged positions, it seemed a sure bet that strict financial reform was to cast a shadow over the alternative investment industry by mid-to-late 2009. In both the U.S. and the EU, reform talks have been heated, and the arguments for and against are numerous. One would suspect that increased regulation would lower the demand for a fund governed by any of these regulations. Furthermore, if EU reforms were to be significantly harsher than U.S. reforms, a corresponding shift in relative demand from the EU to the U.S. would be a reasonable conclusion.

BHA analysts have been gauging demand for funds all over the world, analyzing hundreds of mandates received in the second quarter and the first two-and-a-half months of the third quarter. From this analysis, encouraging and counterintuitive data has emerged that these reform talks have not significantly changed investors’ demand for funds in the U.S. and the EU. Furthermore, it is apparent that the level of relative demand between the two regions has not changed drastically. These two striking conclusions signify that alternative investors are not being swayed by financial reform talks in either the U.S. or Europe.

In the U.S., reform talks have seen both strong opposition and support. Supporters of regulation believe that unchecked hedge fund activity was one of the major causes of the current economic downturn. These supporters have been calling for increased transparency requirements and mandatory registration with the SEC, which would be given nearly unlimited authority to regulate these funds. Critics of reform suggest that the real cause of the financial meltdown was the excessive use of leverage, which has already been removed from the market by almost all banks’ inability to lend. For this reason, they see excessive regulation as overkill that will ultimately be detrimental to the industry. Reform critics also argue that although hedge funds may have used leverage excessively, the mortgage lenders and banks are the firms needing stringent regulations.

It is becoming clear that instead of heavily regulating the hedge fund industry, Congress will pass strict requirements for mortgage lenders and banks. Hedge funds will most likely be forced to register with regulators such as the SEC. Hedge funds will also have to provide an increased level of transparency, which most funds are doing (regardless of requirements) due to the Madoff scandal and the suspicion it cast on the alternative investment industry. So, it looks as if U.S. hedge fund managers are going to dodge a potentially crippling bullet.

Across the Atlantic, European regulators are ensconced in similar regulatory talks. However, the current climate in Europe appears slightly bleaker than here in the U.S. The proposed reforms to EU governance of hedge funds would limit the amounts of leverage permitted, require EU-domiciled funds to use onshore banks, and impose new reporting requirements for a fund. Opponents of these plans fear that an increase in EU regulation would cause a flight of demand to non-EU regulated countries such as Switzerland. Luckily for European-domiciled funds, opposition to these regulatory reforms is mounting by the day. U.K. officials have been strongly against such strict reforms for quite some time, but in recent weeks other European nations have joined the battle. Furthermore, the U.S. and the U.K. have agreed to collaborate on hedge fund reporting by sharing data in an effort to create a common approach to hedge fund reporting and regulatory requirements. It seems that the longer the regulatory debate rages, the more relaxed the requirements imposed by the European Parliament will be.

During these heated debates, BHA analysts have been collecting data and gauging the level of interest for funds focused on these geographic regions. One would think that strict regulatory reform may cause a drop in demand for hedge funds. On the other hand, lenient regulatory reform (like what is probable in the U.S.), would likely encourage more investors to consider alternative investments that were previously seen as risky, unpredictable, and volatile investments. Thus, in theory, it would be logical to see an increase, or at least no decrease, in demand for U.S.-focused hedge funds. On the same note, one might think that demand for European-focused funds would decrease as strict regulatory talks are considered. Furthermore, one might think that debates in these two areas would surely change aggregate demand for the EU and the U.S. combined, possibly shifting investor interest to Japan, continental Asia, or other emerging markets.

The data collected by BHA analysts show why economic theory is not economic law. In the second quarter, 35.16 percent of all mandates collected reflected a specific interest in the U.S. For the EU the number was 26.45 percent. Together, demand for a fund focused on Europe or the U.S. was expressed by 61.61 percent of investors actively looking to allocate capital during the second quarter. In the first two-and-a-half months of the third quarter, 32.89 percent of investors expressed interest in funds exposed to the U.S., while interest in European funds increased to 27.79 percent. Together, this is 60.68 percent of the total mandates collected. These numbers suggest, first, that there has been a slight decrease in demand for U.S.-focused funds, while the EU has seen a slight increase in demand.

A final and telling statistic is demand for European-focused hedge funds relative to U.S.-focused ones. In the second quarter, BHA found that the demand for EU hedge funds relative to the demand for U.S. hedge funds was 75.23 percent. In the third quarter, those numbers jumped to 83.33 percent. So, hedge funds in Europe have become 8.1 percent more popular relative to U.S. funds in just one quarter. This means that investors have not been swayed by the reform talks in Europe, and that these talks (or other underlying factors) have actually increased investors’ interest in the area.

It is important to recall that correlation does not imply causality, but these numbers will certainly allow hedge fund managers in the U.S. and Europe to breathe a sigh of relief. It is true that demand for funds outside these regions has increased, but this increase is slight (roughly .9 percent). The most shocking statistic here is the increase in relative demand for EU hedge funds from the second to the third quarter. However, all of these results have shown that regulatory talks are not drastically altering demand, and for that reason, the alternative investment industry can sleep easily tonight. It is probable that, given the current trajectory of the regulatory debates in both regions, there will be little to no hindrance to funds’ freedom to invest on their own terms. The best news for managers is that investors clearly understand the minimal effect regulation will have, and for this reason, they are not shying away from alternatives in either of these extremely influential world markets.